ECB President Draghi’s comments at Jackson Hole suggested that additional monetary stimulus has become more likely. We expect the central bank to start an ABS purchase programme soon. The chances of a broader QE scheme have increased. Meanwhile, the contrast with his US counterpart’s speech was stark. Fed Chair Janet Yellen made a slight shift in her usual dovish tone to a more balanced one. This suggests that the Fed could raise rates earlier than it is currently signalling, though a rate hike is still some way off.
Draghi opens the door for more stimulus
The speeches of ECB President Mario Draghi and Fed Chair Yellen were the big events on Friday at Jackson Hole. Mr Draghi struck a clearly more dovish tone. The central message in his speech was that the eurozone’s weak labour market and economic performance more generally would be significantly improved only by comprehensive efforts by policymakers to boost not only demand, but also supply via structural reforms. The demand side was of particular interest, because for the first time he called for governments to loosen the fiscal reins. He asserted ‘it would be helpful for the overall stance of policy if fiscal policy could play a greater role’. Of course this should not be without limits, as it should depend on ‘specific initial conditions and legal constraints’. Perhaps even more significantly, Mr Draghi’s comments on monetary policy suggested that additional monetary stimulus has become more likely. He said that ‘we stand ready to adjust our policy stance further’. This is not a new comment, though it is usually followed by ‘if required’, a caveat missing this time. A significant fresh element is concern that inflation expectations – and hence the central bank’s credibility – are being dislodged. The ECB President noted that ‘over the month of August financial markets have indicated that inflation expectations exhibited significant declines at all horizons’.
An ABS purchase programme is on the cards, chances of QE increase
Mr Draghi expressed confidence that the TLTROs – set to be rolled out from next month onwards – would provide the intended boost to demand. He also said that preparations for the ABS purchase programme were ‘moving fast’ and talked about the programme as if it were a done deal. At the press conference following the August ECB meeting, such a programme was mentioned as one of the options to ease policy further. So the ABS programme is set to be the first step in terms of further monetary easing. The chances that the central bank will go further and introduce full-scale QE (a large broad-based asset purchase programme) have also increased. In previous notes, we have estimated that a reasonable size for an initial QE programme would be EUR 400bn. Such a policy action would materialise if the other policy measures appeared to be gaining insufficient traction or if risks to the economy or inflation increased.
Yellen shifts towards more balanced tone
Fed Chair Janet Yellen’s speech showed a slight shift in her usual dovish tone to a more balanced one. This suggests that the Fed could raise rates earlier than it is currently signalling, though a hike is still some way off. To begin with, she delivered a balanced review of the literature on cyclical and structural factors that influence the labour market. She stressed two areas of weakness: the labour force participation rate and the increase in those employed part-time but want full time work. She then discussed wages as a measure of slack and raised some caution. Wages could provide a misleading view given their rigidities. Again here she was balanced and raised the difficulty in distinguishing between cyclical and structural influences of wage inflation. Furthermore, the Fed Chair seems more assured of the improvement in the economy and labour market compared to her testimony in July before the US Senate. That was after the release of the weak Q1 GDP data, which likely resulted in her uncertainty about the economic outlook at the time. This change in tone is an important difference since the FOMC continues to emphasize the data dependency of their policy. She reaffirmed that if the labour market continues to improve more quickly than anticipated by the FOMC, then the rate hike would likely occur sooner, but if the economic situation worsens then it would be later. Ms Yellen now added though that if it comes sooner, then ‘the rate hikes could be more rapid thereafter’. Our base case is that the Fed will raise rates in June of next year, and raise interest rates at each subsequent FOMC meeting in 2015.
FOMC minutes had a clearly less dovish tone
Earlier in the week, the minutes of the FOMC’s July meeting also pointed to a shift in the thinking of many members. They suggest that some FOMC members see a stronger case that interest rates will need to go up earlier than currently anticipated. The minutes recorded that ‘participants generally agreed that both the recent improvement in labor market conditions and the cumulative progress over the past year had been greater than anticipated and that labor market conditions had moved noticeably closer to those viewed as normal in the longer run’. In addition ‘many participants noted that if convergence toward the Committee’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated.’